Below is a chart of Suncor (SU).
First take a look at the RSI buy signal in March. You could have bought the stock at $68 per share (or the call options, which had traded up several hundred percent).
As you can see, after being slightly below 30, the RSI moved higher (showing a higher low) while the stock revisited its same low around $67.80.
This was a "positive divergence" after the RSI saw an upside reversal from $30. If that weren't enough for you to buy the stock (a double-bottom, a positive divergence and a reversal from the $30 level), you will notice that, after the RSI buy signal, the RSI crossed over the centerline as the stock crossed $70, showing that the bulls were clearly in control.
Now, what if you bought it at $76 in late March because you saw it gap up above its $75 resistance? That move paid off for many who took that route, as the stock moved above $82. But let's look at it more closely.
A 'Flat'-out Sell Signal
I highlighted in yellow when the stock essentially traded flat. Usually the RSI would move down near 50 when the stock trades flat (remember?).
Even though the RSI, at that point, moved above 70 -- and even slightly below 70 -- it was no big deal, as it would be normal for the RSI to move even lower when Suncor traded sideways.
The RSI moved even further above 70 to almost 80. What do you think happened next?
That move served as a red flag. But remember, it isn't a sell signal until the RSI drops below 70. When that happens, you want to look for other clues to confirm what the RSI is saying.
* Does the RSI move down, but the stock trades sideways? If so, heed the warning a bit less.
* Does the RSI drop further and cross under 50? If so, then you have your sell confirmation.
Either way, the stock was overbought there, based on the RSI.
When you see an overbought stock, it doesn't automatically mean you should run out and short it. But if you own a stock and see these indicators, you know what you will need to do.
